Q2 2019 Earnings Call
Sure redirect the leader and Investor Relations conferencing, and webcasting and operator will be with you momentarily. Please hold during the silence.
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My name is Brian Healy.
Fly in and give us like a aside from mix.
H E a R U line.
The company that you work for.
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Our aim.
We are.
Thanks, Oh really through the material competition.
Thank you.
Welcome and consecutive quarters of both top and bottom line growth.
An impressive milestone.
Our strong second quarter performance provide significant momentum.
Heading into the second half.
Despite uncertainty around macroeconomic environment and headwinds in select end markets and geographies, we are raising our full year earnings guidance, a second time this year.
Joe will provide financial details for the quarter.
And the full year.
Let me spend a few minutes reviewing strategic commercial actions underway to deliver continued profitable growth.
Last quarter I review, some commercial excellence initiatives and now I will expand on those by providing an update on our one maturity on go to market strategy.
You may be aware, we issued a press release last week announcing the recategorization of commercial end markets.
This announcement was more than simply reclassifying, how we externally report and the market sales.
It highlights changes in how we are identifying new business opportunities and better positioning material to deliver solutions our customers desire.
This end market focus is driving new business opportunities and leveraging the complete one materion product portfolio.
For example.
Our deep customer relationships and market knowledge, and the defense and aerospace market in the PC and PC segments.
Is allowing us to identify new opportunities from am segment.
Likewise market knowledge and position in the semiconductor space for the Ams segment is helping to identify new business opportunities for the PC segment.
In our prior calls I spoke about realignment of the business units based on global product lines.
To complement this we've appointed senior leaders for key end markets to strengthen identifying and developing go to market strategies in support of new business opportunities and supporting customers for the respective end markets.
We have also invested in CRM software and are implementing common processes to categorize capture and report useful information to deliver business growth.
This is an example of the investments, we're making to drive commercial excellence strategies to better serve global customers and growth markets.
Another example of growth investment in our commercial arm is the meaningful progress we are making in developing commercial capabilities in Asia.
This region continues to represent a significant growth opportunity for us.
We have been actively assembling a local leadership team comprised of seasoned professionals experienced in local markets and technologies.
They are identifying growth opportunities and developing local capabilities to deliver on the region's growth potential.
We are leaving similar initiatives to build one maternity and commercial capabilities in Europe .
Following our most recent regional and business unit reviews in Asia.
I am more optimistic than ever about the future of material.
Our differentiated product portfolio.
Innovation capabilities and strategic commercial investments are positioning us to consistently deliver profitable growth.
I look forward to sharing more updates with you on future calls.
Now I'll turn the call over to Joe to cover the financial details.
Thank you drew goal and welcome to everyone joining us on the call today. During my comments I will cover second quarter 2019 financial highlights.
Review profitability by segment.
Provide brief comments on the balance sheet cash flow and modeling assumptions and finally cover the earnings outlook for 2019.
Following my remarks, we will open the line for questions.
I am very pleased to report record financial results for the second quarter of 2019.
This represents the 10th consecutive quarter with year over year growth in both value added sales and adjusted operating profit.
Second quarter 2019 value added sales, which exclude the impact of pass through precious metal costs.
Were $194.9 million, an all time record and up 3% versus the prior year second quarter and up 4% sequentially.
New product sales were $30.8 million or 16% of value added sales.
As Hugo mentioned earlier, we re categorized how we view our end markets and related go to market strategy.
Accordingly, we plan to report value added sales in this revised format going forward.
Strong commercial execution in energy and industrial end markets drove our second quarter growth.
The improved performance in these end markets more than offset continued weakness in the automotive and semiconductor end markets.
The semiconductor end market remains weak primarily due to reduced demand for smartphone devices.
While the automotive end market remains soft, particularly in Europe and Asia.
Despite our second largest end market being down 9%, we delivered the 12th consecutive quarter of year over year value added sales growth.
Strong commercial execution and ability to leverage our differentiated product portfolio has continued to deliver profitable growth.
Gross profit.
Was $69.6 million in the second quarter, an increase of 13% from $61.8 million in the prior year.
Expressed as a percentage of value added sales gross margins expanded 320 basis points to 35.7%.
Driven by favorable sales mix and manufacturing performance improvements.
We continue to have success in driving improved sales mix from a product geographic and end market perspective.
Growth in high purity beryllium products.
And complex optical filters and our res continue to outpace the company average.
Strip product sales in Asia were down almost 30% year over year led by market softness in China, and strategic pruning of some low margin business.
The net result of this purpose full sales mix change combined with manufacturing performance improvements is driving meaningful gross profit margin expansion.
Looking at the first half of 2019 sales mix has been very favorable from an end market perspective.
Sales into the aerospace and defense energy and Telecom data center remained strong.
Representing 33%.
Year to date value added sales up from 30% in the prior year period.
Shifting to selling general and administrative expense.
Cost for the quarter totaled $39.9 million up 1.4 million over the prior year second quarter of $38.5 million.
The increase includes commercial investments to drive our long term strategy.
Partially offset by administrative cost reduction actions.
As a percentage of value added sales SGN, a expense was 20% consistent with the second quarter of 2018.
Operating profit totaled a record $22.8 million in the second quarter of 2019.
Up 50% compared to the prior year second quarter operating profit of $15.2 million.
As a percentage of value added sales operating profit in the second quarter of 2019 was 11.7%.
Also a record for any quarter and the fourth consecutive quarter with double digit profit margins.
Commercial and manufacturing performance improvement initiatives.
Along with general cost reductions drove the year over year increase.
Moving now to other non operating expense.
We recorded a noncash $3.3 million pension curtailment charge in the second quarter of 2019.
Related to our decision to freeze defined pension benefits for active participants in the US pension plan effective at the end of this year.
As you May recall, we annuitized, approximately 43% or $110 million of our us pension liability in the fourth quarter of 2018.
This latest action is another step in our long term goal to reduce volatility and uncertainty related to us pension and benefit expense.
The net impact of the change should reduce the volatility of cash contributions and reduce ongoing annual expense starting in 2020.
Shifting to income taxes, we recorded $3.6 million of tax expense in the second quarter of 2019, which results in a 19% effective tax rate within our full year 2019 guidance range.
Net income for the second quarter of 2019 totaled $15.5 million or 75 cents per diluted share.
Excluding the 3.3 million noncash pension curtailment charge tax affected.
We reported record adjusted earnings of $18.1 million or 88 cents per share an increase of 63% versus the prior year.
Now, let me review 2019 second quarter performance by segment.
Starting with our performance alloys and composites business.
Value added sales were a record $115.3 million up 5% sequentially and versus the prior year.
Commercial execution in this business continues to produce strong results.
Led by sales into the energy and consumer electronics end market and increased beryllium hydroxide sales.
Which more than offset weakness in the automotive end market.
We continue to gain share in the energy end market with our Toughmet and copper beryllium products.
And we also had increased success with engineered strip products utilized in consumer electronic connector applications.
On the negative side, the automotive end market continues to be soft, especially related to demand in Europe and Asia.
Operating profit in the second quarter of 2019 totaled $19.3 million or 17% of value added sales of 57% increase over the prior year and the fourth consecutive quarter with operating profit margins greater than 15%.
We remain focused on our ongoing commercial and operational improvements.
To sustain this positive momentum.
Moving to advanced materials.
Value added sales in the second quarter 2019 were $58.3 million.
2% compared to the second quarter of 2018 value added sales of $57.3 million.
Value added sales increased primarily due to higher sales in the industrial and energy end markets.
Advanced chemical sales for currency security applications drove the industrial end market increase in the quarter.
The increase in energy end market sales was the result of new business wins, and the large area glass product line.
Leveraging the rotated will target technology acquired in their array as high performance target materials acquisition.
Operating profit for the second quarter, 2019 totaled $6.1 million or 10% of value added sales, an increase of 9% versus $5.6 million in the prior year quarter.
The improvement in operating profit is due to sales growth.
Lower metal consignment fees.
And savings from cost reduction actions, which more than offset unfavorable manufacturing yields.
The poor manufacturing yields experienced in Q2 are not forecasted to continue in the second half of 2019.
We remain committed to return this business to the historical operating profit margins by year end.
Turning finally now to the precision coating segment.
Second quarter value added sales were $23.1 million compared to $23.4 million in the second quarter of 2018.
Sales were down slightly due primarily to weakness in the consumer electronics end market more specifically weaker demand in Asia for projector display products.
Operating profit for the precision coatings segment totaled $3.9 million in the second quarter of 2019.
Up 77% compared to $2.2 million in the second quarter of 2018.
As a percentage of value added sales operating profit margin was a record for any quarter at 16.9%.
The increase was due to favorable product mix manufacturing efficiency improvements primarily in the optical coating product line and lower precious metal consignment costs.
If you recall our comments in previous quarters for this business.
Product mix within an end market can significantly impact margins in any given quarter.
During the quarter, we successfully delivered very high end optical filters and arrays into the aerospace and defense end markets.
Looking at the first half of 2019 for this segment operating profit margins totaled 13.2% of value added sales, which is up 100 basis points over the segment's 2018 full year performance.
Moving now to the balance sheet and cash flow.
We generated operating cash flow of $30 million in the second quarter of 2019.
Up versus $29.3 million in the prior year due to higher earnings and lower pension contributions, partially offset by increased working capital requirements to fund sales growth.
The company ended the second quarter of 2019, with a net cash position of $72.2 million compared to a net cash position of 39.5 million at the end of the second quarter of 2018.
Our balance sheet remains very strong.
And we have significant available liquidity to support capital allocation priorities mentioned on previous calls including organic growth opportunities.
Inorganic growth opportunities.
And to consistently return capital to shareholders.
In the second quarter of 2019, we announced an increase to our quarterly dividend of approximately 5%.
Representing the seventh consecutive year of increasing the shareholder dividend.
For financial modeling purposes in 2019.
Capital spending should run approximately $30 million.
Mine development investment should be less than $5 million.
Annual depreciation and amortization should run approximately $40 million.
Due to timing of ore extraction versus pit openings at the mine.
And finally now the earnings outlook for 2019.
We have now delivered 10 consecutive quarters of year over year value added sales growth and profit growth driven by commercial and operational performance improvements.
We remain committed to consistently delivering profitable growth over the long term.
Based on our strong first half performance timing of shipments current order activity strategic investments.
And our current view on end market demand for the remainder of 2019.
We are raising the full year 2019 earnings guidance range to.
$3.10 to $3.25 per share.
The midpoint of this range represents a 33% improvement over 2018 adjusted earnings of $2 of 38 cents per share.
From a quarterly guidance perspective, we expect the third quarter of 2019 earnings to be approximately 10% to 20% higher than third quarter 2018 adjusted earnings.
This concludes our prepared remarks, we will now open the line for questions.
At this time, we'll be conducting a question answer session. If you would like to ask a question. Please press star one other telephone keypad a confirmation tone will indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the Q4 participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys.
One moment, please while we pull for questions.
Our first question is from.
Edward Marshall Sidoti and company. Please proceed with your question.
Hi, guys. How are you good morning.
Hey, good morning Edwin.
Good.
So I'm looking at.
Hey empty to start.
You know I guess theres been plenty of news about a troubled customer there are that many of your customers many of your.
People that you supply have seen some.
Provision to their outlooks.
I'm not I'm not seeing it in your results Im just kind of curious how you've been able to kind of navigate those waters and maybe what you're seeing and maybe how you look at the balance of the year around that particular customer.
Yes.
And we.
As we've already reported we had another quarter of year over year sales growth and 12 consecutive quarter.
And then.
Joe mentioned is that even though semiconductor which is what that customer that you're referring to.
Paul vendor.
Leaving that market was down 9% for us for the quarter.
We were able to still deliver year over year growth and I think thats, where the very very strong diversification efforts that we have in the company are paying off and we are very focused on making sure. The diversification continues.
Across the across the company now with that said, let me just comment a little bit I think on that customer as well as maybe perhaps China in general because.
I wish that fits into the overall China situation.
For us.
Our sales into China are less than 10% of our total value added sales.
Even on it's a meaningful number I mean, it's not it's not a it's not a significant part of our sales. So we we don't have the necessary the exposure that maybe perhaps others that may you may have heard about the half overall for the China, China situation as well as perhaps to that customer.
The second thing is that we are probably two or three or four sort of linked back from the main supply chains that occur into that the in that market. So the fact that we feel is typically lagging maybe lagging two to three months, we are starting to see some slowdown in that in that market from China and from that customer in both I'll say direct sales as well as indirect sales that will feel the effect of you in the in the third quarter.
And perhaps in the fourth quarter, depending on how long it goes but I think I just want to continue to emphasize though that we are really focused on diversification and making sure that we've got a very diversified market.
And and then especially focusing in on and what we would consider higher margin type of markets.
And as a result, we're able to deliver the year over year growth and we're committed to deliver.
Year over year growth on top line.
For the balance of the year I mean, that's our that's our focus.
Gotcha.
And you gave the details on semi.
I also.
I understand there is some telecom.
With Fiveg rollout as well.
That may go to that customer, but you've talked about telecom being very very strong.
Yes in backlog.
Have you seen any impact on the telecom side at all from from.
No in general I mean, we're not we're not seeing a direct impact we have a very diversified customer base. When it comes to the telecom and and data side. So that customer is not the only customer for us in fact with very little I would say direct sales.
To that customer.
And and so we are I would say going into the second half I would classify probably neutral.
In that the overall low overall market.
Got it.
And then finally as we as we look at the reorganization of the segment levels and I understand the kind of the one materion focus I'm curious as you look across three different hi, larger bigger segments that you have advanced materials PC and.
And performance alloys, and composites, where do you think you'll have maybe the initial successes of that cross branding of of material on.
You know.
For instance, maybe.
Maybe automotive in.
Or aerospace and one of the in say advanced materials, I mean, where do you think you potentially will see the most growth and the soonest.
Yes, so I can talk about two three markets. In fact, I think we're actively involved in the defense market is a big big area for US as you know and we're actually actively involved and leveraging our relationships that we have on the PC side, particularly we have relationships on the PC side as well, but we're really leveraging the PSC relationships to pull in our microelectronic packaging business into the into the defense sector much more.
We're looking at the semiconductor side, we've got really good relationships on the ADM side with a number of customers, particularly in in Korea, and so we've got a concerted effort and being able to take advantage of.
Of those relationships and pull in Poland. Phd. So those are just maybe very real time.
Terrific. Examples I can give you of the semiconductor space.
Particularly in Korea, as well as the defense market here in the us.
For our ADM business, we're we're looking at.
How we can expand our business, what we did and we've actually taken senior leaders and I am very very senior leaders in our company and Weve appointed.
Market.
Vice presidents are market leaders submarket executives whatever title whatever title you want to give them.
On to really look at what is the business that we have within that market today.
What are the potential that we could have as it goes lower and how do we step by step bridge to those two achieving those those potentials and I can tell you that our teams are excited about it.
Our our technology rural rollout work that we're doing across the company is starting to come together in terms of putting those three businesses and the teams together. So they can start to leverage each other from the technology perspective.
And and so hopefully we can start to see some real good real good opportunity, we have and in support of this by the way and in General I mean, we are accelerating our efforts for investment.
To to be able to take advantage of this we have a sizeable really meaningful investments growth investments planned for the second half.
In both our R&D and in our commercial arm to support all of these all of these initiatives. So I think.
I think the opportunities are there for us to to get and we're putting the steps in place to build and get those.
Good to hear.
Will be fun to watch.
Joe just real quick.
Depreciation jumped in the quarter I'm, just about $4 million is that is that depletion and if so should I think about.
You may be Pcs margin actually potentially being a little bit higher in the future and just trying to think through yes, so add that due to our revision of our activity in the second half out at the mine. So we will be extracting more ore than previously anticipated.
And so what that does is that drives mine amortization.
Which as you are aware re categorizes it up into inventory so it won't put any pressure on.
Margins from a historical run rate in the PC business.
It will pressure our working capital percentage.
As as it moves it up in inventory.
Got it okay. Okay Thats fair thanks, guys appreciate it.
Thank you thanks.
As a reminder, we are now conducting a question answer session. If you would like to ask a question. Please press star one on your telephone keypad.
Confirmation tone will indicate your line is in the question queue. You May Press Star two if you would like to remove request from the Q4 participants using speaker equipment. It may be necessary to pick up your handset before presents start Q1 on the visa we both questions.
Our next question comes from Phil Gibbs Keybanc capital markets. Please proceed with your question Hey, good morning.
Good morning, good morning, Phil.
I was interested in the.
Commentary on auto specifically I know it was down pretty heavily but you also talked a lot about targeted.
Mix improvements in PBC and I know a lot of this is beryllium copper.
Strip so.
Are these are these also.
Some of the areas where.
You know the mix has been it has been light historically in the past as you as you've really shifted it.
Yes, I think as it relates to mix in automotive or comments, where we saw a particularly down in Asia and in Europe .
I would say.
A portion of the Asia down is not just the market, but intentional pruning as we are driving improvement.
To our mix and again my comments I mentioned in the strip sales in Asia were down approximately 30%.
And that's that's more than just the market decrease.
That was also driven by our strategic decision to prune lower margin business.
I think the other thing Phil to note here, when we talk about mix and good mix and continued improvement in the PC business.
We got to recognize and were really pushing a lot on the aerospace side on the defense side and on the energy side. I mean, those are very important markets for us of course telecom is a is a more of an emerging market with fiveg coming in.
But we've got we've got share gains that were that were delivering in really all three areas aerospace defense and energy.
More more tough Matt for example in and in all three.
Drilling exploration side.
More more parts.
More more material into the into the aerospace with with the content per plane as well as just additional additional planes that were getting content Don.
And all of that business is business that we want to be in it the long term to long term type of contract that we end up into but having with these with these types of markets. So with the model.
Experiencing some of the downturn like you like you mentioned and the downturn that we're experiencing as well, particularly in the in the Asia market, China market I think I think the positive.
Developments in these other markets and our focus on those are the markets is is balancing the drop.
Okay. Good that's kind of what I.
What I hoped or thought you'd say.
In terms of.
Well you have the expected margin targets and am by the end of the year I think mid teens, you reiterated that perhaps a couple of times, but thats also where a lot of the macro challenges are with with semiconductor.
And perhaps consumer electronics in the short term smartphones et cetera.
Yes, Brian I'm trying to think about how you get there with with the macro challenges that you may not have seen.
A quarter or two ago.
Yes, no that's that's a great.
That's a great point the two that you bring up because we are we are we are very focused on delivering top line growth in that business. Despite the macro challenges right I mean.
Semiconductor and total like you mentioned.
The customer that Ed mentioned earlier.
In China.
The overall, China market I mean, so that Ariad has a lot of external factors that are sort of pressing on it.
But I think I think couple of things one we're very focused on delivering on new products in that business. So we have a number of new products that were especially on the memory side that we are that we're really challenging our team to launch and launch quickly. We already are in I'm going to say launch phase and some of them and and pushing to deliver even more faster. So even though we may have some down turn on some of the things that you highlighted and then I've highlighted we're trying to push other things that we can do to to balance on the.
On on that on that on that business I think the second thing is that we can continue to see improvements in our in our integration and acquisition you know that we did we mentioned to you guys in the last few quarters about the new plant that we had open on making sure that we were doing the proper.
We are doing the proper integration of that plant launching of that plant I think thats starting to go well and we continue to see improvement there.
And then and then of course qualifying customers. So that so that we are able to we're able to have have a good.
Good continued growth from that plant we also have.
A good growth in the energy market in that business, we have we have a.
A really nice new business on that on the target side for.
Smart window applications that businesses is progressing really nicely well.
Where we have developed you could almost say a partnership with one of the key customers and so that.
Business growth is starting to now come in.
And then on the second quarter, we did have some as part of these new products. We did have some yield issues because as you can imagine anytime you launch new products and Theres. Some challenges on the manufacturing side and so we did have some yield issues in the second half, which we are really focused on making sure that we're putting those two two meds. So when you put all those things together all is number of things together I mean, we feel we feel that we'll continue to make progress on this business and and exit the year at that mid teen, but I will tell you. It is it is very very challenging and in fact, it's probably give becoming lot more challenging than what we thought at the beginning of the year.
And because of I think the continued headwinds from the overall end market side, but but immuno us we're not giving up we're we're making sure that we've got all the levers that we can pull to exit and mid teens by the by the end of the year.
That's a that's really helpful.
So sounds like sounds like an approach kind of on all sides in terms of both products and.
And then also some of the integration and cost efforts too. So that's that's good to hear.
Yes.
On the pension comments.
I think Joe you had made some in terms of the Annuitization you guys have done some really good work with the balance sheet in.
Yes, I guess on on a lag here.
Because pension expense I think its been pretty stable last couple of years, you expect to see some improvement and.
In 2020 can you just remind us what what that what that not expenses right now and just give us a little flavor of what it what it could be.
Yes, so when you look at the net expense now for our US pension plan, it's running around let's say $7 million on an annualized run rate.
And so going forward that service costs.
We will go away component of it.
It will be replaced with the DC contribution so from a whole piece the endpoint there won't be.
A benefit where the benefit will come is down and other non operating.
Expense there you will see a benefit of approximately $2 million year over year, but as you know that depends on asset return assumptions and discount rates.
But based on where we sit today, we would anticipate approximately a $2 million.
Savings year over year.
Thanks, guys very much.
Okay. Thank you Phil.
We have reached the end of the question answer session I will now turn the call back over to Steve Shamrock for closing remarks.
Thank you.
This is Steve Shamrock and this concludes our second quarter 2019 earnings call. A recorded playback of this call will be available on the company's website Materion dotcom, we'd like to thank all of you for participating on the call. This morning, and your interest in Materion.
I will be available to answer any follow up questions. My direct number is 2163 Athree 401 zero. Thank you very much.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.